Thursday, October 6, 2011

HPQ - using options to trade the range

CCI is long and wrong two lots of Hewlett Packard.  CCI developed a strategy to manage this loosing position in this article.  One of the main premises of that article is that HPQ's valuation is providing some base for the stock, but it will meet strong selling resistance in the high $20s for a long while.  In an attempt to repair some of the damage from this trade and exit the position,  the article describe an initial option trade. The trade is built around the assumption that the stock would  bounce around a lot in a range between the low and high $20s. CCI has had one round trip using this strategy.

Recent volatility saw HPQ trading below $22 earlier in the week and $25 today.  (Once again an example of those "efficient and rational" markets CCI was able to buy a lot of $24 Nov options late last week and this week sell 2 lots of Nov. $28 calls. This basically mimics the original trade described in the article.   With the high implied volatility of the options and the 2:1 ratio, the trade was established for a net credit of $.22/share.  

In "option speak" this would be considered a 1x2 ratio spread which can also be viewed as the combination of a $24-$28 vertical call spread and $28 cov calls.  From a more common sense perspective the following scenarios are in play.

- Pullback - HPQ falls back below $24 - CCI keeps the $.22 (just under 1%) to lower the losses of the position and will still own two lots of shares that are deep underwater.
- Sideways - HPQ moves mostly sideways over the next weeks ending at $26.  CCI will make $2 on the call spread and keep the option premium from the covered call and still have two lots of shares that are less underwater. .

- Rises over $28 - CCI makes $4 on the call spread, keeps the premium from the covered call, and one lot of shares is called away at $28. (My target price)
- Volatility continues and CCI will be able to leg out of  (and maybe even back in) to these option positions

Stay tuned.

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